New Trading Strategy in Investment: A Study of the Hedge Funds From Emerging and Developed Markets

Abstract

This paper introduces a new trading strategy in investment: to include the asset (Asset A) with the highest mean, the asset (Asset B) that stochastically dominates many other assets, and the asset (Asset C) with the smallest standard deviation in their portfolio to form the portfolio in the efficient frontier. To test whether our proposed new trading strategy performs better, we set a few conjectures including the conjectures that investors should include any one or two or three of Assets A, B, and C. We test whether the conjectures hold by employing both mean-variance and stochastic dominance (SD) approaches to examine the performance of the portfolio formed by using hedge funds from emerging and developed markets with and without Assets A, B, and C, the naïve 1/N portfolio, and all other assets studied in our paper. We find that most of the portfolios with assets A, B, and C stochastically dominate the corresponding portfolio without any one, two, or all three of the A, B, and C strategies and dominate most, if not all, of the individual assets and the naïve 1/N portfolio, implying the existence of arbitrage opportunities and the market is inefficient. Our findings also confirm our proposed new trading strategy to include Assets A, B, and C in the portfolio is the best strategy among all the other strategies used in our paper and get the highest expected wealth and the highest expected utility. Our findings contribute to the literature of hedge funds and the reliability of alternative risk frameworks in the evaluation. Our findings also provide practical experience to academics, fund managers, and investors on how to choose assets in their portfolio to get significantly higher expected utility.

Keywords: Hedge fund strategies; Relative value; Equity hedge; T-Bill; Portfolio optimization; Stochastic dominance

JEL Classification: C4; D81; G11; I10